Is the Euro Crisis Over?

Robert Guttman, Guest Blogger

A strange calm has settled over Europe. Following Mr. Draghi’s July 2012 promise “to do whatever it takes” to save the euro, which the head of the European Central Bank followed shortly thereafter with a new program of potentially unlimited bond buying known as “outright monetary transactions,” the market panic evaporated. Since then super-high bond yields have come down to more reasonable levels, allowing fiscally and financially stressed debtor countries in the euro-zone to (re)finance their public-sector borrowing needs a lot more easily than before. Even Greece has been able to borrow in the single-digits for the first time in three years.

This calming of once-panicky debt markets has led to optimistic assessments that the worst of the crisis has passed. Draghi himself declared at the beginning of the new year that the euro-zone economy would start recovering during the second half of 2013. He talked of a “positive contagion” taking root whereby the mutually reinforcing combination of falling bond yields, rising stock markets and historically low volatility would set the positive market environment for a resumption of economic growth across the euro zone. Christine Lagarde, as the head of the IMF part of the “troika” (i.e. ECB, IMF, and European Commission) managing the euro-zone crisis, declared at the World Economic Forum in Davos a few weeks ago that collapse had been avoided, making 2013 a “make-or-break year.”

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News from The Global Development and Environment Institute

The International Monetary Fund issued new guidelines on the use of capital account regulations, and GDAE’s co-sponsored Task Force on Regulating Capital Flows has continued to track and engage with the process. In a widely syndicated piece for the Project Syndicate, Gallagher called the reforms an important “half step,” important for acknowledging the value of such tools for developing countries to prevent damaging swings in currency values and contagion from international financial markets. His Pardee Policy Brief, “The IMF’s New View on Financial Globalization: A Critical Assessment,” goes into more detail. His Financial Times piece circulated widely, as did a piece on the issue by The Globalist, which appeared in China Daily, Valor Econômico (Brazil), The Financial Express (India). Gallagher also authored a provocative article in Global Policy, “Social Costs of Self-Insurance” that shows that the another way to regulate capital flows—by accumulating foreign exchange reserves—can be quite costly for emerging market and developing countries.

GDAE released new analysis of the incompatibilities between the new recognition of the validity of capital regulations and most U.S. trade agreements, which prohibit them. Gallagher teamed with the co-chair of a Pardee Task Force Leonardo E. Stanley to publish a policy brief, “Global Financial Reform and Trade Rules: The Need for Reconciliation,” in advance of the full Task Force Report, slated for release in March. Gallagher reiterated the contradictions in meetings with congressional leaders, and published his perspective in Al Jazeera, “Trade rules should not constrain fixing global finance.” While GDAE continues its work on Capital Flows and Development, Gallagher has been awarded a grant from the Institute for New Economic Thinking (INET) to collect some of his analysis on capital flows into a book.

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For a Place in the Sun

Sunita Narain

How will solar energy be made to work in India? As I discussed in my previous article there are three key challenges. One, how will the country pay for solar energy in a situation where there is no money to pay for even the crashed costs of installation. Two, what is the best model for the distribution and use of this relatively expensive energy in a country where millions still live in the dark? Three, how should India combine the twin objectives of supply of clean energy and creation of domestic manufacturing capacities?

The government proposals for funding the differential costs of solar are twofold. One, under the National Solar Mission phase II draft guidelines the Ministry of New and Renewable Energy has proposed a viability gap funding for new projects. In other words, it wants to go back to the era of capital funding, which has been riddled with problems. For instance, wind energy suffered because the operator had no real incentive to generate power; it only eyed benefits of capital finance and depreciation. The plants’ performance was abysmally low; therefore, generation-based incentive was introduced. It paid the differential but only based on actual power generation. Reversing this will be disastrous in a sector where there is a huge gap in performance of systems. Capital funding will be used without consideration for efficiency and output.

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The Island Dispute Between China and Japan: The Other Side of the Story

Robert Wade

The current dispute between China and Japan over a few barren islands inhabited by goats – called Diaoyu in Chinese and Senkaku in Japanese – looks at first sight to be a mere territorial spat. But it has escalated to a very dangerous level in recent months — first words, then actions of police forces, now actions of air forces, and, behind all these, both sides have mobilised all their military, political, economic, diplomatic, and cultural energies to engage in the dispute. It is more fundamental than normal territorial disputes, because the very identities of the two countries are at stake.

A strong narrative has taken hold in the West and much of East Asia about China’s behaviour, which starts with the proposition that China is the provocateur. Examples include, “China sows new seeds of conflict with neighbours”;[1] China has adopted an “increasingly sharp-elbowed approach to its neighbors, especially  Japan”;[2] “China…has launched a new campaign of attrition against Japan over the Senkaku islands…. Beijing has sought to challenge Japan’s decades-old control, despite the risk that an accident could spiral out of control”.[3]

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The Next Crisis: Undermining Democratic Legitimacy

Daniela Schwarzer

In the euro area, the crisis mood has somewhat calmed down. Several events in late 2012 have reduced the tensions. Among them are the European Central Bank’s announcement of its bond-buying programme OMT, the agreement on the creation of a banking union (however incomplete it may be for the time being) and the launch of the permanent European Stability Mechanism (ESM). The relief the euro area is experiencing at the moment may, however, only be temporary. Risks are emerging all over. The more obvious challenges still lie in the financial sector and in public finances – and further  steps of crisis management and integration may indeed prove necessary to tackle them. Less obvious and more complex to solve are the political and social challenges.

The debate on the EU’s democratic legitimacy has gained pace. The European Union is quite used to discussing its democratic deficiencies. This post argues that the current crisis adds new dimensions to an old problem. The immature governance structures of the currency union prevent it from providing what European integration has been based on since its start: output legitimacy. While it is today (still) uncontested that European integration contributes to maintaining peace on the continent, it is hard to argue that the euro zone has sufficient instruments at hand to ensure long-term economic growth, social stability and sustainable public finances.

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Reviving economic planning in Africa

Martin Khor

For many years after independence, developing countries made use of development planning as a major tool of getting their economies going.

But this stopped in the 1980s and 1990s for many countries, especially in Africa, that fell under the influence of the International Monetary Fund and the World Bank.  Under their structural adjustment programme, planning or any kind of development strategy involving a leading role of the state was taboo.

As a result, many African countries fell behind in their economic growth and social development.  Governments gave up planning, withdrew their leading role in the economy, cut jobs, gave up on subsidies and other methods of helping local firms and farmers.  The new order was to privatise, liberalise imports and rely on foreign investments for growth.

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New IMF research validates critics’ concerns

Ilene Grabel

I’m imagining that things have gotten a little chilly for some in the IMF’s cafeteria.  Why? Two important studies coming from different quarters of the Fund validate important and long-standing criticisms of the institution.

The first is a recent report by the IMF’s Independent Evaluation Office (the IEO), an internal body that conducts notably refreshing and often critical audits of various aspects of IMF performance.  In an especially hard hitting (and on target) report, the IEO takes on the IMF’s work on exchange rate issues and specifically on “excess” foreign reserve accumulation in some countries during the period 2000-2011. After 2009, we should recall, IMF economists began to argue that excess reserve accumulation contributed to global financial instability. The report provides support for what many Fund watchers have long argued—namely, that the Fund has used the charge of excess reserve accumulation as a Trojan horse to advance the interest of its most powerful members in pushing countries like China to move toward more flexible exchange rates.

The same IEO report finds that the Fund’s analysis of excess reserve accumulation was analytically deficient on several grounds.   First, the report’s authors argue that there is scant academic evidence for setting upper or lower limits to countries’ reserve levels (though the IMF has attempted to do so via a reserve adequacy metric since 2011). Second, the obsessive focus on reserves meant that Fund staff overlooked the precautionary motives that caused some countries (in East Asia and elsewhere) to amass massive reserves.

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Econ 4 The Bottom Line: Regulation

We are economists who think that the economy should serve people, the planet and the future.

Rules are as important in an economy as they are in sports. When gamblers rig the game, players flout the rules, or competent referees are not on the field, the result is a charade and not a fair contest.

Yet some claim that regulations are always bad for the economy. They believe that “freeing” business from rules that protect public health, maintain competitive markets, and ensure financial solvency is the route to prosperity. This ideological opposition to regulation, epitomized by the repeal of the Glass-Steagall Act, dismantled the firewall between commercial banking and investment banking, and opened the door to the greed and reckless behavior that culminated in our current economic crisis.

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Democratizing Finance

Sasha Breger Bush, Guest Blogger

Back in 2003, Yale economist Robert Shiller noted in his book The New Financial Order, “We need to democratize finance and bring the advantages enjoyed by the clients of Wall Street to the customers of Wal-Mart” (1).  More recently, Shiller’s 2012 article in The New York Times connects suggestions to “democratize finance” to the Occupy Wall Street Movement: “Finance is substantially about controlling risk. If risk management is suitably democratized, and if its sophisticated tools are better dispersed throughout society, it could help reduce social inequality.” Among Shiller’s proposals, in the older book and more the recent article, are for income insurance based on occupational derivatives and financial innovations to manage old age risks, thereby reducing pressures on welfare based entitlements like Social Security. Efforts to democratize finance in the advanced industrial economies are mirrored in development policy circles, where officials from the World Bank and UNCTAD, among other agencies,  have been recommending for many years now that certain kinds of derivatives markets (largely for commodities and the weather) be re-tooled to better meet the needs of the agrarian poor.

On the surface, such efforts appear to be rather successful. As I detail in my recent book, derivative exchanges have proliferated across the developing world over the past several decades, with 23 of the top 50 derivatives exchanges (by volume) located in the global South in 2010.  This same year, the most rapidly growing derivatives exchanges in the world were located in Asia and Latin America.  Between 2003-06, commodity derivative contract volume outside of the OECD well surpassed that within. And, in 2009, China’s Securities Regulatory Commission announced that China had become the largest commodity derivatives market in the world, contributing over 40% of global volume. On the micro level, commodity and weather derivative contracts are being transformed into retail products, designed for use by smaller and poorer actors who have traditionally been excluded from global derivatives trading—e.g. retail crop insurance based in weather derivatives markets (“weather-index insurance”), agricultural producer bonds with built-in price insurance (like Brazil’s rural product bonds), and other mechanisms for passing on the risk management services of derivatives to those unable to participate directly in the markets.  What could be more democratic?

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Is Income Distribution Holding Up the Recovery? Stiglitz Versus Krugman

Matias Vernengo

A friendly debate between Stiglitz and Krugman (and also further comments here) on the role of income distribution in the recovery has been getting some attention in the blogosphere. Note that I don’t think neither Krugman nor Stiglitz would deny that worsening income distribution was not relevant for the crisis, even if they were slower than some heterodox economists like Jamie Galbraith or Bob Pollin, to name two, in emphasizing the role of inequality. The question is whether inequality has been central for the slow recovery in the last few years.

Stiglitz’s main reason for suggesting that the recovery has been stifled by inequality is that “middle class is too weak to support the consumer spending that has historically driven our economic growth.” Krugman, for some reason, thinks that this argument is a long run one, and suggests that while: “it’s true that at any given point in time the rich have much higher savings rates than the poor. Since Milton Friedman, however, we’ve known that this fact is to an important degree a sort of statistical illusion. Consumer spending tends to reflect expected income over an extended period.” However, he thinks that “you can have full employment based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs.” In other words, worsening of income distribution might actually help the recovery.

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